The Diversification Model

Safety versus reward…

When I was just starting out buying rental property, an investment opportunity came on the market that totally captured my fancy. It intrigued me so much, I came very close to acquiring it – and making a major error at a very early stage of my real estate investing career. The property was an eight unit set of townhomes, all attached, and owned by a local bank that had taken them over when the developer defaulted. The project was totally finished – nothing had to be repaired, fixed up, renovated…a truly turn-key operation among investment properties. Of course, new tenants would need to be found for it, which would take several months after a closing to gain full occupancy.

Thinking pragmatically

I negotiated directly with the bank, and they were willing to provide the loan, with investment property mortgage rates that were very beneficial for me on the property. And the numbers, which I got into a habit of crunching several times a day, every day for a few weeks, kept making more and more sense. So – why didn’t I acquire the property? Simple – it would have used up every penny I owned in available capital. Any mistake on my part in my numbers crunching meant I could potentially lose money  as I was just learning about investing in rental property.  And it could happen quickly – without any means to tap a “slush” fund for emergencies…not only for the townhomes, but for myself personally. In effect, I could lose everything I owned on this one set of real estate investments.

Listen to your inner self for the danger signs

I could sense the danger every day I got more and more serious about closing the deal. Ultimately, common sense prevailed. While the upside was also quite large on this grouping of townhome investment properties, and would have set me up, in theory, quite nicely moving forward, the downside, as I evaluated it was equally nerve-racking. I just didn’t have the stomach. So I backed out of the potential deal.

A self-taught lesson in fiscal restraint

This offers a good lesson – as I taught myself – in the need for diversification in any type of real estate investing. To have put all my eggs in one basket, at the beginning stages of my property investing career, would have been a very risky, and probably fool-hardy thing to do. When I applied reason to my analysis, I came away with other options, like picking and choosing smaller multifamily homes, one at a time, that were much less risky. Again – not as much reward, but no one property would sink me like this townhome project could if I was wrong in my calculations.

Basic property investment theory

Diversifying is such an integral part of investing theory, and yet when confronted directly with the prospect of a “big kill,” the notion of diversification can easily go out the window, especially when dollar signs go up in the sky in big bold letters.

In real estate, this means diversification can have many looks. You can diversify across one class of properties – for example, sticking entirely within residential real estate, and acquiring individual homes as I have done. It can also mean spreading risk out over several classes, or types of real estate investments. Owning a small office building, a retail store property and a multifamily home at one time are a good way to diversify your real estate holdings.

Eschewing the big kill mentality…

With more diversification comes lessened risk – as a downturn or a financial hit to one segment won’t totally destroy your overall holdings. It’s slow and steady financial gains that are approached as an averaging of all your different real estate holdings in the diversification model. In this way, real estate investors can protect themselves, and can be ready in the event of any downturn…Ready to acquire another, different class of investment property moving forward.

 

photos courtesy of  besthawaiihomes. com, elementcommunity.com, worldpropertychannel.com,  chrismercer.net, rifuture.org